Beware banks bearing hybrid offers

Richard Livingston

The spruikers are out pitching NAB convertible preference shares and Westpac capital notes – the latest hybrid offers from our major banks.

If you've logged on to your CommSec account recently, you'll have seen the "apply now" button. If you've got an adviser or broker you've probably received a call. These latest offers are no worse than earlier hybrid offers, but there's no reason to be clicking buttons or saying "yes".

In early 2012, when the hybrid market was going gangbusters, investors were eschewing cheap bank shares with double-digit dividend yields in favour of equity-like hybrids paying single-digit returns.

Investors wanted higher returns than term deposits were offering, but didn't want to watch share prices bounce around like a yo-yo. We thought a simple strategy – term deposits and ordinary shares – was better, but we understood investors' desire to avoid volatility.

Now, we human beings are a crazy lot, particularly when it comes to investing. Bank shares have been on a roll recently, so they are far more expensive than they were in 2012, and hybrids, in comparison, are more attractive. Plus, a key risk of the earlier hybrids – exposure to falls in the price of the ordinary shares – has been alleviated by the recent good performance.

You'd think this might see the earlier hybrids – for instance, CBA PERLS VI, ANZ CPS3 and Westpac CPS – in demand. But, whilst bank shares have been shooting for the stars, their prices have been drifting.

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ANZ CPS3 has recently traded at a slight discount to its $100 issue price.

You'd also be forgiven for thinking it would be tough to sell the new NAB and Westpac hybrid offers when investors can buy the earlier, risk-reduced hybrids at similar or better margins.

NAB and Westpac are offering 3.2 per cent above the bank-bill rate for investors willing to fill out the application forms and wait. A few computer keyboard strokes might get you CBA PERLS VI or Westpac CPS (already listed on the ASX) at the same margin or better.

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The earlier hybrids aren't identical to the new offers, so be sure to understand the fine-print before signing up. Mind you, we'd argue they're better (and some even earlier versions better again).

The point is, if you've applied for NAB CPS and Westpac Capital Notes, you've either formed the view that they are superior to the earlier hybrids or you've sacrificed both risk and returns. We suspect, in many cases, retail investors have blindly followed "advice" and done the latter.

If the retail investing world was fully informed and devoid of skewed financial incentives, NAB and Westpac would be struggling to get their offers away. Why would someone try to sell you Westpac capital notes when Westpac CPS is simpler to buy, lower risk and offers similar returns?

But it's not. Retail investors face an information asymmetry – they know less about the products they are buying than those being rewarded for selling them. So ask yourself the question: why are you buying NAB and Westpac hybrids?

If you can't mount a more convincing argument than "my adviser recommended them" then you should think again.

Richard Livingston is the managing director of Intelligent Investor Super Advisor, an online service providing SMSF and investing advice. This article contains general investment advice only (under AFSL 282288).